It is always good to start with the fun­da­men­tals of sup­ply and demand. In terms of sup­ply, crude oil reserves are still very large. The Inter­na­tion­al Ener­gy Agency (IEA) esti­mates that there are 1.6 tril­lion bar­rels of oil across the globe. In the Unit­ed States, the Ener­gy Infor­ma­tion Admin­is­tra­tion (EIA) pub­lished that there were 38.2 bil­lion bar­rels of proved oil at the end of 2020. In terms of demand, how­ev­er, the pic­ture is more com­plex. This is large­ly because the devel­oped world is expe­ri­enc­ing a flat or very low sin­gle-dig­it growth rate for crude oil demand, while the devel­op­ing world is see­ing mean­ing­ful demand growth. In fact, 90% of cur­rent glob­al oil demand growth is from Asia, per the IEA. The table is set for a new era for oil, based on these themes.

First, Asia cre­ates a nat­ur­al hedge that under­pins crude oil demand, such that sup­ply will con­tin­ue to be made avail­able. The devel­op­ing world has shown lit­tle appetite thus far for strict adher­ence to the var­i­ous cli­mate frame­works. Instead, the gov­ern­ments in devel­op­ing economies nat­u­ral­ly seek afford­able eco­nom­ic growth and a high­er stan­dard of liv­ing. This might cause oil pric­ing to migrate to non-USD trans­ac­tions. While the growth of elec­tric vehi­cles (EVs) will impact the demand for oil and refined prod­ucts in the devel­oped world, it remains to be seen how fast and far EVs can expand in devel­op­ing coun­tries. And just as the search for oil when oil prices were high led to dis­cov­er­ies of large reserves of nat­ur­al gas, so too will the search for more nat­ur­al gas serve to uncov­er more crude oil reserves.

Sec­ond, the war in Europe high­lights the impor­tance of ener­gy secu­ri­ty and diver­si­fi­ca­tion. The US oil com­plex presents a per­fect storm of tech­nol­o­gy inno­va­tion, ESG con­sid­er­a­tions, cap­i­tal dis­ci­pline, and skills that mean it can and should take mar­ket share. This will help to sta­bi­lize glob­al oil mar­kets from dis­rup­tive geopo­lit­i­cal shocks. I think there will be height­ened aware­ness of cap­i­tal flow­ing to regimes that are not good actors, because this has an Envi­ron­men­tal, Social, Gov­er­nance (ESG) impact, both the ​“S” and the ​“G.”

Third, there is an often-over­looked point about oil and the ener­gy tran­si­tion. Oil can fund a great deal of the ener­gy tran­si­tion. Cur­rent cash flows from crude oil are already being deployed by large ener­gy com­pa­nies to fund the devel­op­ment of clean and renew­able ener­gy. There is a grow­ing push here in the US for the cer­ti­fi­ca­tion of ​“green bar­rels,” mean­ing oil pro­duced from wells that have very tight air and water con­trols on them. Also, while the oil indus­try may not agree, many of the his­tor­i­cal investors in oil and gas pre­sume that oil will large­ly dis­ap­pear as a trans­porta­tion fuel in the next decade, and they are there­fore con­cerned about ​“ter­mi­nal val­ue” or the abil­i­ty to recov­er their invest­ments in lat­er years. US shale drilling, with its much faster recov­ery of cap­i­tal, is far more appeal­ing than the near­ly decade-long cap­i­tal recov­ery peri­ods for many poten­tial inter­na­tion­al oil and gas devel­op­ments. Any effort to fill the gap between demand and cur­rent­ly con­strained sup­ply may depend large­ly on US oil and gas com­pa­nies and their ESG-con­scious investors, both of which would need to be on board. Old ener­gy can be a source of cap­i­tal for new energy. 

So, what does it mean? The ESG move­ment will mean that bet­ter play­ers or stew­ards in the oil busi­ness will draw cap­i­tal away from bad play­ers. The M&A mar­ket in the oil indus­try should accel­er­ate, from large caps all the way down to small caps, as there is a shuf­fling of assets and indus­try con­sol­i­da­tion. I expect more cap­i­tal to flow back into the oil busi­ness for all these rea­sons, and it is already happening.

Tom McNul­ty’s thoughts have been fea­tured in the Hous­ton Chron­i­cle. Read the arti­cle here.